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Avoiding the Hazards of Diversification

Because of over diversification, the merger and acquisition craze, and the use of
extraordinary debt, many firms have had to restructure in late 1980s and early 1990s.

- R.E. Hoskisson and M.A, Hitt

Most institutional investors would prefer to choose which industries they invest in
themselves, rather than add another layer of conglomerate managers to make that
choice for them.

Companies also attempt to diversify their product line to enhance the value of the firm
through economies of scope, economies of scale, and market power, among other
goals.

By diversifying the firm’s product lines, top executives reduce the risk of losing their
own jobs.

Outcomes of Acquisitions for Diversification


Increase in size of organisation.
Conglomerate acquisitions tend to produce negative performance outcome i.e. this
type of acquisition may increase net profit in short terms but tend to have negative
effect on shareholders wealth in long period of time.

Majority of unrelated acquisitions are divested in a short time after that purchase.

Acquiring related versus unrelated business

Many of the holder more established conglomerate firms experienced performance


difficulty and had to restructure by down scoping the firm to refocus on more specific
business areas.

Acquiring related business

Synergy is created when competency and resources can be shared across business.
It leads to economies to reduce cost.
Related acquisitions are often undertaken to spread the geographical diversification of
a firm.
Achieving synergies to gain the benefit of related diversification acquisition is
challenging. It requires careful and thorough planning and coordination as well as
effective integration of two firms acquiring unrelated business does not necessitate
this coordination and integration.
Acquiring unrelated business

Unrelated diversification is based on the premise that financial synergies can be


achieved in a firm with a widely diversified portfolio of businesses.
There are no other opportunities for synergies as in the related diversified firms.
Loss of strategic control; they do not have adequate knowledge to evaluate the
strategies selected by the managers of each business.
Business level managers are less willing to invest in action that may produce positive
returns in long term but could reduce in short term.
Unrelated acquisitions are often least successful ones.

Problem with acquisitive diversification

The primary reason for poor performance and changes such as the inability of the
firms to achieve the synergies either in the sharing of resources and capabilities or in
financial resources allocations.

This problem begins with conflicts and differences in styles and strategies between
the two firms.

Acquisitions are highly complex strategies to design and implement and they are only
further complicated by acquiring firms with product lines that differ from the firms
current core businesses.

Learning from Diversification

The most valuable diversifying acquisitions from learning point of view are those that
are more highly related to the firms core business.
It is more difficult to learn from unrelated businesses that are acquired, because the
knowledge basis have much less over lap, the knowledge learned over the long term
relates to developing new technological capabilities, a more complex form of learn.
It creates product diversity and international diversity.
Manager can develop competencies in managing internal diversity.
Without appropriate transfer pricing policies, conflict could ensure.

Conclusion and Managerial Implications

Diversifying performance do not necessarily leads to positive performance outcomes.


They only have the opportunities to produce financial synergies.
Acquired firms that are related to the acquiring firms core business have a higher
probability of leading to positive out comes.
Therefore, management philosophy and culture should be taken into account when the
acquisition decision is made.
This usually requires managerial emphasis on learning and special action taken to
ensure that new knowledge is created and codified.
This particularly true as firms learn from product diversification and move into
international markets.
Less diversified firms are more innovative .firms following an aggressive acquisition
strategy of often invest less in R & D to produce innovation and instead acquire
companies with new products.

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